August 06, 2012

Second Circuit Revives CDO Wash-Out and Paper Price-Fixing Cases

The Second Circuit today came out with rulings in two big commercial cases.

The first involved a "collateralized debt obligation", the second a cartel that the plaintiffs alleged fixed prices for "publication paper". Plaintiffs won both times.

The CDO case stemmed from a $60 million purchase in December 2006 by a German bank, Bayerische Landesbank, of shares, which took the form of "Notes", in a $100 million "synthetic" CDO. A shell entity that Aladdin Capital Management and Goldman Sachs set up served as the Issuer of the Notes.

Aladdin acted as the Portfolio Manager. The Portfolio consisted of debt securities.

The Issuer sold a credit default swap -- a sort-of insurance policy -- to Goldman Sachs. That meant the Issuer would have to pay GS lots and lots of money if debt securities in the Portfolio suffered adverse Credit Events, such as downgrades or payment defaults.

You know the rest. The debt markets went haywire in 2008 and 2009. The Portfolio had Way Too Many Credit Events (a total of 11). And that sent the value of the Notes to zero.

Bayerische Landesbank sued Aladdin for reckless handling of the risk in the Portfolio. The district court dismissed the case. The Second Circuit -- per U.S. District Judge Jed Rakoff -- reversed the ruling and sent the case back.

The panel held that Aladdin owed a duty of care to the bank both as a third-party beneficiary of Aladdin's Portfolio Management Agreement with the Issuer of the Notes and as grossly negligent tort-feasor by virtue of Aladdin's close relationship with the bank. The court also ruled that the complaint alleged a plausible case of gross negligence against Aladdin -- mainly because it seems to have let Goldman Sachs run circles around it in its (unsuccessful) efforts to avoid Credit Events. Bayerische Landesbank, New York Branch v. Aladdin Capital Mgmt. LLC, No. 11-4306 (2d Cir. Aug. 6, 2012).

[Judge Rakoff, btw, does a stupendous job of laying out how the whole synthetic CDO concept worked -- or, in this case, didn't (except for GS). Blawgletter says check it out.]

In the price-fixing case, a class action, a district court in Connecticut granted summary judgment on a claim that competing makers of publication paper conspired to fix prices. In re Publication Paper Antitrust Litig., No. 11-101-cv (2d Cir. Aug. 6, 2012). The outcome resulted largely from the fact that two long-time Finnish friends, Markku Tynkkynen and Kai Korhonen, met secretly to talk about pricing shortly before their respective companies announced price increases. Cuts in production capacity also helped raise an inference of non-independent conduct.

The U.S. Department of Justice lost a criminal trial against the paper-makers in July 2007. Tynkkynen and Korhonen testified at the trial, and that explains why the plaintiffs in Publication Paper knew so many details about their doings.